What Is the Biggest Drawback of Refinancing Your Home Mortgage?

Closing costs can undermine the savings in a refinance.

To refinance a mortgage, a borrower must qualify for the new mortgage and pay considerable closing costs, the same amount needed to purchase the home. The biggest drawback to refinancing is the closing costs.

Significance

The closing costs of a new mortgage, regardless of a refinance or a purchase, can range from 3 percent to 6 percent of the total value of the mortgage. These costs, if rolled into the mortgage, will eat into the equity that has been built up in the home.

Function

The closing costs of a mortgage serve to pay all the vendors and government agencies involved in closing a loan. These include the lender, appraiser, closing attorney, local and state tax offices and the insurance company handling the homeowner's insurance.

Considerations

To calculate to see if it is a good idea to refinance your mortgage, divide the total closing costs by the monthly savings. The result shows the number of months it will take to recover the money spent on closing costs. If it takes less than two years to break even on the closing costs, it is usually a good idea to proceed with the refinance.

Misconceptions

If you are not planning on staying in the home for much longer than it takes to break even on the refinancing expenses, it is in your best interest to forgo the expense of the closing cost and simply try to pay down your mortgage faster.

Prevention/Solution

Negotiate any closing costs associated with the loan, especially the origination fee, to get the best deal. Also, shop around for closing attorneys or title insurance companies in your area to find the best rate.

References

• FederalReserve.gov: A Consumer's Guide to Mortgage Settlement Costs
• FreddieMac.com: Down Payments and Closing Costs